Working Capital Calculation – Regression Analysis Method

The Regression analysis, a statistical tool, is used to estimate the working capital and its components. It establishes an equation relationship between revenue and working capital. It can also be called trend analysis because the relation is carved out based on past trend. Without going into technical details, this method says ‘Working Capital = Intercept + Slope * Revenue’.

The standard equation is stated as below:

y = a + bx

In our case, y represents the working capital because that is to be forecasted. x represents sales as it is the base for finding out the working capital. a & b are intercept and slope. A slope is the rate of change of working capital with one unit change in revenue. Intercept is the point where regression line and working capital axis meets. At the end of the statistical exercise with past revenue and working capital data, we will get an equation as explained above with real values of a and b. Then we will be able to find out y (working capital) for a given x (forecasted sales).

How to Calculate Working Capital using Regression Analysis with Formula and Example

Let us try to understand what we have to do for getting our estimates rather than understanding too much technical statistics. See the following table. The first column is a year, a second is sales and third is working capital. As we required the past data for future forecasting, here we have our past data. The fourth column is the product of sales and working capital and a fifth is the square of sales.

Sr. No. Year Sales Working Capital Product of Sales & WC Square of Sales (x) 
(x) (y)  x*y x2
1 2001 100 55 5500 10000
2 2002 110 64 7040 12100
3 2003 121 80 9680 14641
4 2004 130 70 9100 16900
5 2005 150 90 13500 22500
6 2006 180 120 21600 32400
7 2007 181 100 18100 32761
8 2008 190 140 26600 36100
9 2009 230 150 34500 52900
10 2010 250 160 40000 62500
Gross 10 1642 1029 185620 292802
Total Years
Denotation n Σx  Σy  Σxy  Σx2

Once this table is ready with n, Σx, Σy, Σxy and Σx2. We will solve the following equations.

Formula = Σy = na + bΣx Formula = Σxy = aΣx + bΣx2
Will replace the formula with values we have Will replace the formula with values we have
1029 = 10a + 1642b 185620 = 1642a + 292802b
Multiply by 1642 Multiply by 10
=>  1689618 = 16420a + 2696164 ———– Eq. (1) =>  1856200 = 16420a + 2928020b ———– Eq. (2)
Subtract Eq. (1) from (2), we get,
166582 = 0 + 231856 b
=>  b = 166582/231856 = 0.7185
Now, replace b = 0.7185 in our old eq. 1029 = 10a + 1642b
We get, a = -15. 078

After all this exercise, we get the following equation,

Working Capital (x) = -15.078 + 0.7185 Sales (b)

Now, if the forecasted sales for the year 2015 are 300, the working capital as per this method would be 200.472. (Working Capital = -15.078 + 0.7185 * 300 = 200.472). In the similar fashion, all the components can be calculated.

Advantages and Disadvantages

The advantage of this method is that it is based on the regression analysis which is a proven method of forecasting. Bigger the amount of data we have, better are the chances of accuracy with this method. Its drawback is that it is not simple like percentage of sales method. The understanding and calculation, both are difficult and lengthy. 

Other Methods for Estimating the Working Capital Requirements

Percentage of Sales Method

Operating Cycle Method

Last updated on : June 18th, 2018

** Disclaimer: This post may contain Affiliate Links marked as ** and we may earn a commission on sale.

What’s your view on this? Share it in comments below.

One Response

  1. Arun kumar

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.